Plan to Exit versus Plan at Exit

As a Founder or Entrepreneur, many of you built companies with an eventual exit in mind.? The question is, did you build your company for exit and are your expectations properly set?

We sold our business and closed on it just over a week ago.? From the very beginning, this was an investment so an exit was always the plan. ?In 2017, we had purchased an existing business that in our estimation, was underperforming.? We thought this would be a 5-year road with a 5x growth.? We had big plans.? Then COVID.? Then hyper-inflation and sky-rocketing interest rates.? I can make a million excuses as to why we did not hit 5x.? The reality is, we did very well but just didn’t quite hit our target.? And as a founder, you should build plans that have some level of “oh sh*t” in them.

Here are just a few of many things you should be thinking about well before marketing your business for sale.

1. First and foremost, did you set yourself up as a C Corp (and optimally a Delaware C Corp)?? If you are an S Corp or LLC, you still have time to change.? You would want a C Corp versus the other two (or B Corp which is less common) if the plan is to grow and offer an IPO, sell to an investor (PE or VC) or private sale with an expectation of savings on taxes.? Most people see C Corps as a double taxation.? And they are, upfront.? But, at an exit, the shares of a C Corp can be sold and your capital gains can avoid taxation.? You heard that right, no cap gains tax.? Do yourself a favor and read up on section 1202 of the IRS tax code. If you hold your stock for 5 years prior to sale and total gain is less than $10M or 10x the adjusted share value, you likely qualify.? Talk to your tax attorney and CPA about this.
2. Is the accounting for your business on the back of a bar napkin?? Time to straighten this out.? If you are good with QuickBooks or other similar software, look at example charts of accounts for others in your industry.? Make sure your books are set up similarly.? Make sure the compensation you are taking out of the business is clearly listed. ?This includes all perks.? When it comes time for an actual offer, that needs to be easily added back to your EBITDA and cannot be a last minute “but wait, my country club is also in there as a marketing expense and it is listed as Google AdWords”.? Is all of your revenue and all of your expenses easily identifiable. If your books are a mess, one of two things will happen; due diligence is very short and the buyer walks away OR you are devalued in the offer as the confidence in how the company is being run is in question.
3. Take a really good look at all of your existing contracts to run your business.? Long term contracts are a potential liability to a buyer as that limits change they can make.? IT service contracts, cellular phones, computer leases, auto leases, software licenses… all of it.? I am not saying you should get out of all of these contracts, just know them and know the out-clauses.? Buyers will ask and some may want those bought out on your dime.
4. What about your employees?? If you are a service business, that is what you are selling.? Do they have equity in your company?? Are you going to keep your sale confidential or are you telling everyone.? If you were running a 10-15% annual employee turnover and you tell employees you are selling, that may skyrocket and devalue your business.? We were a service business and sold confidentially.? There was no blip in our turnover and that was attractive to the buyer.
5. Are you selling your Accounts Receivable?? Do you know your historical bad debt amount annually?? When a buyer offers to buy that, they will come in at a discount of the total value.? Know what you are willing to accept based on your historical performance.
6. Be prepared for bumps in the road.? When we listed our business, it was immediately following COVID.? It takes some time to get buyers interested and tire kicking and due diligence may take even more time.? Just as we had 4-5 interested buyers, interest rates shot through the roof.? The SBA loan rate was at almost 10.75% for new applicants.? Credit tightened at the same time and banks wanted us to have skin in every deal on top of larger expected down payments and capital requirements from the buyer.? That immediately shrank our buyer pool.? If you are dying to get out, you can take those deals but they obviously shrink your return.? Or, you can be patient and wait out the storm.? Either rates will drop and credit will loosen, or you will find that perfect cash buyer.? Anything can happen.
7. Don’t go buy a boat just yet.? Exiting a business can be costly to the seller. ?So while you think you have a mountain of money coming it, it might only be a foothill’s worth.? Your CPA will be working double time to get your books in order and will likely need to answer a lot of detailed questions from a buyer.? Those hours are not free.? Your attorney will need to spend days if not weeks reviewing your contract and addendums. ?If you own company real estate, how do you hold that?? Is it a separate LLC because that will not qualify for 1202 treatment.? Gain on sale for that asset will hit your C-Corp books and the taxes will need to be left behind for the buyer to pay those.? Same thing with your federal and state corporate taxes.? Did you use a broker to sell your real estate or business, yes, more fees.

My disclaimer for the above, I am not a registered investment advisor, attorney of any sort or a CPA.? The above is simply a guide for things you should think about and be prepared to ask your trusted advisors all of these questions.? If you are looking to exit and simply need some advice, shoot me a note.

If you are looking at your current valuation and need a hand with profitably growing prior to sale, Mahdlo can help.? Click here to schedule up to one hour free to discuss your situation and see how we can help.